For years now, Sears Holdings Corp. has been reporting declining sales at both its Sears and Kmart stores. Most recently, in the firm’s fiscal 2010, same-store sales fell 1.6 percent—dropping 3.6 percent at Sears and rising 0.7 percent Kmart. It was just the latest annual decline for the firm. Same-store sales fell 5.1 percent in 2009, 8 percent in 2008, 4.3 percent in 2007 and 3.7 percent in 2006. During that time span, Sears Holdings’ net sales dropped by nearly $10 billion, from $53.0 billion in 2006 to $43.3 billion last year.

Yet the firm survived the recession while many others failed. But the two brands have continually struggled to find a niche in the retail sector and ceded market share for years.

Observers questioned the tie-up of the two firms from the beginning and many still wonder whether the brands can survive long term. To a large extent, that might depend on what Sears Holdings decides to do with its real estate, according to five retail and retail real estate consultants interviewed by Retail Traffic. (Sears Holdings declined to comment.)

In spite of its lackluster performance, the Sears chain has several things going for it, including a well-known name and several well-respected consumer brands, including Craftsman tools and Kenmore appliances. If Sears Holdings puts more emphasis on its hard goods and either cuts down or improves its apparel offerings, it has a good chance of reinventing itself, says Craig Johnson, president of Customer Growth Partners, a New Canaan, Conn.-based retail consulting firm. In order to do so, however, Johnson notes Sears would have to shed about a third of its stores.

There appears to be less hope for the Kmart chain, which has failed to gain any market share in the discount game over the past decade against formidable competitors like Target and Walmart. Overall, Sears Holdings ranks as the ninth largest retailer in the U.S. by annual revenue—a steep drop after occupying the No. 1 slot for many years up to the 1990s.

As of January 2011, Sears Holdings operated about 3,500 stores in the U.S. The most valuable of these include 908 so-called “broadline” Sears stores, which are based in some of the best malls in the country. In addition, the company operates 1,287 specialty Sears stores, which are either freestanding or located in neighborhood shopping centers and 60 Sears Essentials stores, also a freestanding concept.

Unlike Sears stores, most of the Kmarts are positioned in weaker locations in secondary markets, notes Jeff Greep, president of Jeff Green Partners, a Phoenix-based real estate consulting firm.

The consensus among the experts Retail Traffic spoke to is that this portfolio is too large to allow Sears Holdings to run a profitable retail operation. The good news is that observers believe a sizable portion of the stores can be subleased. The firm occupies locations at some of the best malls in the country. Sears Holdings owns many of the sites outright and has long-term leases at below-market rents on others.

“They have very desirable real estate, there is no question about that,” says George Whalin, founder of Retail Management Consultants, a Carlsbad, Calif.-based consulting firm. “When they started building those stores in the late 1950s and early 1960s, there were spaces available that aren’t available today. That real estate will be very desirable for retailers that are looking to expand.”

The question going forward will be whether there is enough demand to fill all of the spaces that get put back on the market. There are few expanding retailers and many available boxes at power centers today, which would cut into the potential pool of tenants to backfill excess Sears space, says Green. That might mean that some landlords will be left with empty anchor spaces if Sears Holdings does opt to shut locations.

Clean-up job

In his letter to shareholders, dated Feb. 24, Sears Holdings chairman Eddie Lampert acknowledged that the chains’ performance remains unacceptable and announced new initiatives to help drive sales in soft goods, including the launch of a Sofia Vergara fashion line at Kmart and UK Style by French Connection and the Kardashion Kollection lines at Sears.

Around the same time, Lampert announced the appointment of Lou D’Ambrosio, a former IMB executive and CEO of telecom equipment company Avaya, as the company’s new CEO. D’Ambrosio’s lack of experience with retail operations or, in fact, with any direct-to-consumer business, makes it seem like Lampert is looking to revamp the retailer’s entire business model, says Johnson.

That model is likely to focus on further cutting down the cost of doing business and whenever possible, subleasing unprofitable stores to other retailers, according to Whalin. Sears has already started doing this in 2010, first signing a deal with apparel seller Forever 21 for a 43,000-square-foot space at South Coast Plaza in Costa Mesa, Calif. and then a deal with Whole Foods for a 34,000-square-foot store in Greensboro, N.C.

In his letter to shareholders, Lampert indicated the company was seeking more third party retailers to lease its underperforming stores. In all, it closed 34 Kmart and full-line Sears stores in fiscal 2010.

Though Sears Holdings is behind many other department store chains in trying to trim its portfolio, ultimately the strategy is the right one, says Cynthia Groves, senior managing director of global corporate services with real estate services firm Newmark Knight Frank. She believes both Sears and Kmart have staying power, but need to drastically downsize their fleets.

“They are realizing that they have to look at their store size, the way the stores are configured, the number of their units,” she notes. “Lampert will use the real estate to turn the retail around. They go hand-in-hand.”

Real estate play

Given that many of Sears’ broadline stores are located in markets with high barriers to entry the company shouldn’t have too much of a problem finding takers for those units, says James Bieri, CEO and president of the Bieri Co., a Detroit, Mich.-based real estate consulting firm. Some of the same retailers that are expected to backfill Borders’ locations—Forever 21, Costco and Target—might jump at the chance to lease Sears locations, especially since it will save them the trouble of paying for a full store build-out.

Likewise, some of the Kmart stores might be picked up by discount concepts like Big Lots and Salvation Army, Bieri notes. In many cases, Kmart pays single-digit rents, so if an alternate retailer wants to be in a given market, it might be possible to sublease those stores.

The problem is that demand for new space is still out of whack with the amount of vacancies available in the market, says Green. Plus, a chain like Forever 21 would only want to sublease the space from Sears if there are a lot of years left on the original lease. In some cases, however, Sears will be facing expiring leases on underperforming stores and it will be forced to exit the property without providing the landlord with a new anchor.

“My professional gut is that they are at least 25 percent too large a company,” notes Green. Subleasing their stores, however, “definitely won’t take care of their entire portfolio. There are not that many alternate users out there, especially given the fact that so many power centers have abundance of vacancy.”